Forget GDP, it’s a rubbish indicator of well-being

ScreenHunter_4458 Oct. 13 08.54

By Leith van Onselen

Fairfax’s Ross Gittins wrote a good article over the weekend questioning the economics profession’s infatuation with Gross Domestic Product (GDP), which Gittins argues is becoming an increasingly useless measure of economic well-being:

To estimate real GDP the bureau takes the nominal, dollar value of the goods and services produced, then “deflates” this figure by the prices of those goods and services relative to what those prices were in the base period.

We commonly take the value of the goods and services we produce during a period to be equivalent to the nation’s income during that period…

But [Saul] Eslake reminds us that “for an economy like Australia’s, the prices of whose exports are much more volatile than those of other ‘advanced’ economies, abstracting from swings in the prices of exports (and imports) obscures a significant source of fluctuations in real incomes”…

Trouble is, real GDP doesn’t capture the effects of these swings…

Next Eslake says that as the resources boom moves into its third and final phase – with mining investment winding down and exports ramping up – real GDP growth will be an even less useful guide to what’s happening to domestic income and employment.

This is because maybe 80 per cent of the income generated by resources exports will be paid to the foreigners…

(A separate issue Eslake doesn’t mention is that the highly capital-intensive nature of mining means the increased production of mineral exports will create far fewer jobs than you would normally expect)…

Last month I wrote an article arguing that “economists’, the media’s, and the Government’s infatuation with GDP is one of the biggest shortcomings in macro-economics”.

This infatuation with real GDP growth has led to spurious (and damaging) policies like the pursuit of endless population growth on the basis that it stimulates headline GDP (more inputs equals more outputs), even though it provides next to no benefits to everyone’s share of the economic pie and arguably reduces living standards of the pre-existing population.

Then there is the focus on the quantity of growth in GDP, rather than the quality (and sustainability) of growth, such as frivolous debt-fuelled consumption and the Government and RBA’s never ending drive to increase house (land) prices and private debt, which creates structural imbalances and damages longer-run productivity and competitiveness.

Finally, there are other anomalies with GDP, touched upon above by Gittins and Eslake, of which there is no better illustration than the pick-up in the volume of commodity exports as the mining investment boom ends. The transition from the mining investment boom to an export boom will see the loss of a large number of jobs – up to 100,000 according to NAB. And yet the rising export volumes will largely offset the negative growth impact from falling mining investment, effectively supporting GDP as unemployment rises materially.

To make matters worse, the increase in export volumes has dramatically lowered export prices (i.e. more goods are being sold at lower prices), yet this reduction in national income is not captured in headline GDP, which only measures volumes produced within an economy.

Accordingly, Australian real per capita national disposable income (NDI) has fallen by 1.9% since December 2011 despite the 2.8% growth in real per capita GDP over the same period, with further divergence likely as the terms-of-trade continues to fall (see next chart).

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The sooner economists and commentators abandon GDP as a measure of economic progress, and replace it with broader measures of well-being, the better.

As noted last time, the ABS is thankfully developing new ways of measuring Australia’s progress, which includes a bunch of qualitative factors such as health, safety, equality, etc. Let’s hope that it gains greater prominence amongst commentators and policy makers alike.

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    • migtronixMEMBER

      Wow! Then we call be as happy as the severely remote Bhutanese. Parasailing with falcons and peregrines will be the only measure that matters…

    • Not so happy after all 🙁

      ‘Mr Tobgay, 47, said that while he supported the notion that “economic growth is not the be-all and end-all of development”, GNH should not distract from tackling Bhutan’s pressing problems, including chronic unemployment, poverty and corruption.

      “If the government of the day were to spend a disproportionate amount of time talking about GNH rather than delivering basic services, then it is a distraction,” he said.

      “There are four issues that can compound to make matters extremely bleak: our ballooning debt that if we’re not careful will not be sustainable; the big rupee shortage; unemployment, in particular youth unemployment; and a perception of growing corruption.”

    • migtronixMEMBER

      A general review is presented of the pattern of population change in mountain areas of the Hindu Kush Himalaya mountains, located in Bhutan, China, India, Nepal and Pakistan. It is predicted that the mountain population will double during the next 20-30 years before growth rates begin to decline. Population control programmes alone will not be effective in slowing population growth if economic transformation does not proceed concurrently. Increasing environmental degradation and poverty are unlikely to discourage people from having larger families. Economic development of mountain areas will probably be relatively slow, despite the fact that opportunities differ from one country to the other. Economic growth will also have long term environmental costs.

      So much better;jsessionid=A6C25F30D7EA1DAB5F1AF30789A2B825

    • The idea is that we should be looking at multi-factorial measures. Not just a number that has little correlation to the standard of living for most average citizens.

      While GNH is at the extreme end, there is always a good middle ground. But no, you clowns have to rubbish everything …

  1. Re. the big population is good because it’s good idea, if there was any truth to it then surely China & India must be heaven on earth…

    When I think of countries around the world that you would actually want to live in, I can’t see any correlation with population size, if anything, the (mostly Nordic) countries that rank highly on quality of life surveys have relatively small, stable populations.

  2. Indicators aside, this line was the essence of the story “This is because maybe 80 per cent of the income generated by resources exports will be paid to the foreigners”. Australians have sat on their hands and their wallets while our wealth has been exported overseas. You reap as you sow.WW

    • Yup, while young generations try to eke out a life, the boomers sold off the export generating aspect of our natural endowment for a couple of European holidays.

      • And gen x, the first of whom are entering their fifties should also get a dishonourable mention.

        In fact, distinctions between gen x and boomers are pretty minimal in every respect.

      • Quibble Rusty…. gross generalizations about age groups is as bad as the metric GDP. One might look at the political agency over the last 50ish years and what segment of society pushed it.

      • How many xers you know that even paid off the mortgage emess. They have been trying to save a deposit or in private debt hell for as long as they can remember.

        After all we had keatings fine recession as he set the scene for the private debt boom.

        All the xers I know we’re too busy following the debt rules to realise they were getting shafted. Maybe just maybe the ones getting close to fifty, but late thirties to forties – no chance.

      • I know who pushed it, I’m asserting who accepted the push to allow it through, and despite the continued bleating of me seniors moment above with hid “what about Gen x, they’re 50 ya know!?!”.

        The bogan boomer was told his little piece of ‘equity mate’, coupled with their individual exceptionalism would lead to untold, and deserved, riches.

        Despite every economic metric sinking, despite the defeaning cries of Gen x and younger thus burden is excruciating, the bogan boomer went on its merry way condemning the future of the country and the only change they made was to suppress the voices of the young.

        But hey, they ‘deserve’ those $50k a pop holidays to Europe

  3. Famously, GDP measures the value of goods and services, so an outbreak of Ebola, a war or a rash of car crashes adds to GDP.

    GDP also measures $100 worth of wheat with the same value as $100 of Christmas tree lights.

    GDP does not measure negative externalities, like climate disruption, air pollution, rising noise and other negative impacts from overpopulation. Finally, GDP as a gross measure is meaningless without some sort of per capita comparison.

    What has been found is that GDP per capita and the Genuine Progress Indicator rise pretty much in tandem until they reach about $20,000 per head. After that, GDP per head continues to rise but GPI flattens out.

    Peter Strachan

    • Tedblack44MEMBER

      Worse still is the fact that the number is an average. Winners plus Losers equals average ????? and a positive is good? Not much of a snapshot. Household stats by income percentile please.

      • Correct,
        The latest stats from The Economist show how the workforce is being hollowed out. A lot of those good middle level jobs have gone for ever since 2008. Most of the new jobs are low paid, service jobs plus very few high paid jobs. So wealth disparity is widening in capitalist societies with the top 10% of wage earners taking 40% to 50% of total income, compared with 30% just 35 years ago.

  4. ‘As noted last time, the ABS is thankfully developing new ways of measuring Australia’s progress, which includes a bunch of qualitative factors such as health, safety, equality, etc’

    ABS would be well advised to stick to statistical data, avoiding any interpretation of qualitative (subjective) measures.

    Perhaps they should reallocate resources from projects such as the one mentioned above to sorting out the basics like the employment data schmozzle.

    And yes, welcome back!

    • Btw I think there is already a US think tank (Harvard based ?) that assesses a range of qualitative measures across countries (legal framework, corruption, education, health, GDP, etc) – Australia is always in the top 10. Pretty damn good.

    • I don’t see why you conflate qualitative and subjective. ‘How many people in Australia felt they were in good health this year?” is subjective, but “How many people in Australia lost a limb (or digit or whatever) in a workplace accident?” can be objectively answered. Why shouldn’t objective qualitative measures be included in ABS data gathering?

      • You’ll see.

        In your example above, what are you measuring? Health? Workplace accidents? Safety? Amputations? Etc

    • The point is that GDP is a useless figure. It is logically as useful as using Coles’ sales metrics to measure the profitability of BHP.

      So the obvious thing is to get rid of it, full stop.

      The issue then becomes, do you want it replaced? If so, with what?

  5. properly done measure of unemployment (including measure of underemployment and job satisfaction) should be used instead

  6. Even the author Simon Kuznets of the GDP metric publicly stated that it was not designed for the use put to it.

    The concept of GDP was first developed by Simon Kuznets for a US Congress report in 1934.[4] In this report, Kuznets warned against its use as a measure of welfare (see below under limitations and criticisms). After the Bretton Woods conference in 1944, GDP became the main tool for measuring a country’s economy.[5] At that time Gross National Product (GNP) was the preferred estimate, which differed from GDP in that it measured production by a country’s citizens at home and abroad rather than its ‘resident institutional units’ (see OECD definition above). The switch to GDP came in the 1990s.

    The history of the concept of GDP should be distinguished from the history of changes in ways of estimating it. The value added by firms is relatively easy to calculate from their accounts, but the value added by the public sector, by financial industries, and by intangible asset creation is more complex. These activities are increasingly important in developed economies, and the international conventions governing their estimation and their inclusion or exclusion in GDP regularly change in an attempt to keep up with industrial advances. In the words of one academic economist “The actual number for GDP is therefore the product of a vast patchwork of statistics and a complicated set of processes carried out on the raw data to fit them to the conceptual framework.”[6] – snip

    Simon Kuznets, the economist who developed the first comprehensive set of measures of national income, stated in his first report to the US Congress in 1934, in a section titled “Uses and Abuses of National Income Measurements”:[4]

    The valuable capacity of the human mind to simplify a complex situation in a compact characterization becomes dangerous when not controlled in terms of definitely stated criteria. With quantitative measurements especially, the definiteness of the result suggests, often misleadingly, a precision and simplicity in the outlines of the object measured. Measurements of national income are subject to this type of illusion and resulting abuse, especially since they deal with matters that are the center of conflict of opposing social groups where the effectiveness of an argument is often contingent upon oversimplification. […]

    All these qualifications upon estimates of national income as an index of productivity are just as important when income measurements are interpreted from the point of view of economic welfare. But in the latter case additional difficulties will be suggested to anyone who wants to penetrate below the surface of total figures and market values. Economic welfare cannot be adequately measured unless the personal distribution of income is known. And no income measurement undertakes to estimate the reverse side of income, that is, the intensity and unpleasantness of effort going into the earning of income. The welfare of a nation can, therefore, scarcely be inferred from a measurement of national income as defined above.

    In 1962, Kuznets stated:[28]

    Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

    Austrian School economist Frank Shostak has argued that GDP is an empty abstraction devoid of any link to the real world, and, therefore, has little or no value in economic analysis. Says Shostak:[29]

    The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption. For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

    So what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping. We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world.

    The UK’s Natural Capital Committee highlighted the shortcomings of GDP in its advice to the UK Government in 2013, pointing out that GDP “focusses on flows, not stocks. As a result an economy can run down its assets yet, at the same time, record high levels of GDP growth, until a point is reached where the depleted assets act as a check on future growth”. They then went on to say that “it is apparent that the recorded GDP growth rate overstates the sustainable growth rate. Broader measures of wellbeing and wealth are needed for this and there is a danger that short-term decisions based solely on what is currently measured by national accounts may prove to be costly in the long-term”.

    Many environmentalists argue that GDP is a poor measure of social progress because it does not take into account harm to the environment.[30][31]

    In 1989 Herman Daly and John B. Cobb developed the Index of Sustainable Economic Welfare (ISEW), which they proposed as a more valid measure of socio-economic progress, by taking into account various other factors such as consumption of non-renewable resources and degradation of the environment.

    India and China have the largest population in the world and hence has the greatest potential in productivity due to the fact that the value of a product is measured as the value of service that can be obtained by the holder in exchange for that product. ( Units per man hour) – snip

    Skippy… how some attach a quasi religious like attitude to number sets and abstract models, that are so skewed toward a sector, is ludicrous, even if by intentional design.

  7. I hate to say it, but to my knowledge, the Measures of Australia’s Progress, may fall victim to the ABS cuts. This is despite the fact that it was one of the first national statistics providers to design and implement a national measures of social progress.

  8. How about the release yesterday of the ACOSS poverty prevalence as another measure of national economic functioning or dysfunction.

    Approximately 1 in 7 below poverty line. A bit of it about. But what until Kevin Andrews into stride.